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Macroeconomic Analysis of Legislative Proposals

Posted by Doug Elmendorf on

May 9, 2013

As part of its budget resolution for fiscal year 2014, the Senate incorporated a “request for supplemental estimates” from CBO. For legislative proposals that would have a significant impact on federal revenues, the Chair or Ranking Member of either the Senate or House Budget Committee can ask that CBO prepare “to the extent practicable, as a supplement to the cost estimate for legislation affecting revenues, an estimate of the revenue changes… that incorporates the macroeconomic effects of the policy being analyzed.”

Although this provision is new and focuses on revenue effects, CBO has been doing estimates of the macroeconomic effects of certain legislative proposals—and of the feedback from those macroeconomic changes to the federal budget—for some time. Consistent with long-standing procedures underlying the Congressional budget process, such feedback effects are not included in cost estimates for legislation being considered by the Congress. But those cost estimates encompass many other types of behavioral responses. Here’s the relevant excerpt from CBO’s web page describing how we do our work:

what sorts of behavioral responses are included in your estimates?

CBO’s analysts try to judge whether proposed policies would affect people’s behavior in ways that would generate budgetary savings or costs, and those effects are routinely incorporated in the agency’s cost estimates. For example, the agency’s estimates include changes in the production of various crops that would result from adopting new farm policies, changes in the likelihood that people will take up certain government benefits when policies pertaining to those benefits are changed, and changes in the quantity of health care services that are provided when Medicare’s payment rates to providers are changed. (Similarly, in its estimates of the budgetary impact of tax legislation, the staff of the Joint Committee on Taxation accounts for behavioral responses to changes in the tax system—for example, changes in the timing and amount of capital gains realizations when the tax rate applicable to capital gains is modified.)

However, CBO’s cost estimates generally do not reflect changes in behavior that would affect total output in the economy, such as any changes in labor supply or private investment resulting from changes in fiscal policy. That is, CBO’s cost estimates generally do not include what is sometimes known as “dynamic scoring.” The convention of not incorporating macroeconomic effects in cost estimates, a practice that has been followed in the Congressional budget process since it was established in 1974, primarily reflects several facts: Doing macroeconomic analysis of all proposed legislation would not be feasible; nearly all legislation analyzed by CBO would have negligible macroeconomic effects anyway (and thus negligible feedback to the federal budget); and estimates of macroeconomic effects are highly uncertain.

Such macroeconomic analyses require complex modeling and a significant amount of time, so they can be produced only for major proposals and reports, and only if time allows. In addition, the analyses capture just some of the channels through which proposed policies would affect the economy, and the resulting estimates of macroeconomic effects may be even more uncertain than estimates of the direct budgetary effects of those policies.

Because of its potential effects on the size of the U.S. population and labor force, immigration legislation raises some unique estimating issues. In a recent letter to Congressman Paul Ryan, we described how CBO would analyze the economic effects of proposals to make major changes to immigration policy, using as an example the agency’s 2006 cost estimate for S. 2611, the Comprehensive Immigration Reform Act of 2006. Because that bill would have had the direct effect of significantly increasing the size of the U.S. labor force (resulting in an estimated 3.4 million additional workers in the United States by 2016), CBO and the staff of the Joint Committee on Taxation (JCT) relaxed the standard assumption that overall economic activity would be unchanged and incorporated in the cost estimate the direct effect of the bill on the U.S. population, employment, and taxable wages. Nevertheless, the estimate did not include a full range of macroeconomic effects. In a separate memorandum that accompanied the cost estimate, CBO described the effects that were not taken into account in that estimate (specifically, the impact on private saving, capital flows, and interest rates, and the resulting effect on wages), and the additional budgetary effects that would ensue. CBO and JCT anticipate taking a similar approach for any forthcoming legislation that would make major changes in immigration policy.